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Leonard Hyman & William Tilles

Leonard Hyman & William Tilles

Leonard S. Hyman is an economist and financial analyst specializing in the energy sector. He headed utility equity research at a major brokerage house and…

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What Exiting The Paris Agreement Means For U.S. Utilities

Power Cables

Even businesses with a vested interested in denying the vitality of the green energy movement have begun to recognize its potential. The head of Aramco, Saudi Arabia’s state oil company, recently pre-dicted a “global transformation” and his counterpart at another oil major, Royal Dutch-Shell, described the green movement as “unstoppable.” Electric vehicles mean less oil consumption. Senior managers are admitting the games afoot so to speak.

Closer to home, Jeremy Grantham, a pillar of the Boston investment community and one of the most respected investors in the U.S., commented on the clean energy movement that: “I think it’s happen-ing much faster than most well-educated business people in America realize. Because the science is being deliberately obfuscated in the U.S., the consequences are being obscured as well.”

The Financial Times concluded that President Trump was trying to “unwind” President Obama’s clean energy policies, but that "in the rest of the world… the future of green power appears assured.” Presi-dent Trump does not think so, apparently. Attempts by various segments of the business community to keep the U.S. in the Paris agreement seem to show that they may see an opportunity in climate mitigation.

Industry researchers predict solar electric power generation will be even more competitively priced (vis a vis fossil generation) by 2020, reaching three cents per kwh. And, they predict, solar power com-bined with battery storage could provide electric grid competitive services by 2030. If correct, the problems of coal and natural gas suppliers to the electric industry will derive mainly from economics and not government policies. Removing the U.S. from the Paris agreement will have little impact on fuel mix or competitive advantage.

But it actually gets worse. Despite the President's action, a growing reliance on renewable energy sug-gests that a significant percentage of electric utility equipment presently in use, no matter how recent-ly installed and "undepreciated", will be at risk from technological obsolescence. Stated another way, a new technology with zero fuel costs might produce the identical commodity product as the old plants, electricity, but at a lower overall cost--all considerations of externalities and carbon taxes aside for the moment--which would make renewables all the more compelling.

Let’s consider whether the U.K.-based Financial Times story is correct in the sense that political leaders here in the U.S. refuse to appreciate the gravity of global climate issues, or simply don’t understand green energy and are engaged in a sort of energy-related American exceptionalism.

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First, the pace of technological change (as one new technology gradually supplants another) is uneven and often occurs over many decades. Some consumers are passionate about new technologies while others cling with equal fervor to the old. Ditto for producers of the competing products.

In the electricity business, though, it is the large commercial and industrial customers, typically operat-ing in fiercely competitive global markets, that will select power suppliers purely on price and not ide-ology, sentiment or prior relationship. But eventually as with all commodity products electricity includ-ed, it all comes down to price. If new entrants offer identical products at lower prices, adoption rates of the new technology escalate that much faster.

Until recently, various U.S. government bodies, both regulatory and administrative, have used subsi-dies—mostly tax rebates and net metering schemes—to nudge consumers to adopt renewables. As the economics of solar-plus-storage, for example, approach or decline below grid parity, will govern-ment subsidies still be necessary or appropriate? We doubt it.

The utility industry has rightly objected to retail net metering--paying consumers for excess electricity generated from their renewable devices at the retail rate regardless of time of day or season. Net me-tering can place a utility in an unenviable business position of having to pay the relatively high retail price for a customer’s excess electricity for which it in turn may find little or no demand. Net metering, however, has been more of a state than Federal matter.

So, what’s the problem, then? We see it coming from our government’s policy makers bringing a lais-sez faire approach to energy policy, designed explicitly to aid domestic oil, gas and coal. In contrast, other nations subsidize, support and export renewable products. They also put government money into designated national champions and devote considerable sums to R&D.

Traditional political conservatives — and there are some left — don’t like to choose winners or losers, or allocate government resources to corporate/industrial "champions", or invest public funds when private firms could do so just as well, the cost of money aside. We agree with them, in principle. Ex-cept in this case the other guys are doing it. Should we cede potentially large international and domes-tic markets to foreign firms producing products that address one of the major environmental issues of the century?

Environmental and state regulators, as well as transmission organizations, may take their cues from climate skeptics in the Federal government. So, not being convinced of the existence of a problem, they see no looming competitive threat to franchise owning utilities. Or they may lack authority to do something about it, even if they saw the problem. Either way, these agencies may hinder the indus-try’s attempts to respond. Because response costs money.

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First the distribution network requires re-engineering for a time when customer demand is more elas-tic and the distribution network connects, not just utility with the consumer, but multiple buyers and sellers.

Second the utility needs to more rapidly write off unproductive assets, regardless of vintage, through faster depreciation. Unless revenues increase by an offsetting amount this will mean lower reported earnings, which ultimately means lower dividends.

Or industry managers, in the face of regulatory inflexibility, could decide this so-called threat is not re-al, elect to do nothing and simply wait. If our scenario of a gradually emerging competitive threat is even remotely correct, then this path simply leads to more abrupt asset write offs. The downside of the see-no-evil strategy is that regulators may balk at permitting full recovery of now suddenly obso-lescent plant, exposing utility and shareholders to a greater loss in value.

We don’t know if American business executives in general are behind the green energy curve. But we do know that most of the action, at least initially, will involve the electricity, automotive and software industries. Expansion of the electric vehicle market suggests electricity might gradually cannibalize the market for gasoline. It would be ironic indeed if, at the same time, renewable technologies supplanted franchise-owning electric utilities.

The U.S. electric utility industry’s leaders know their firms won’t survive without getting ahead of the curve. The industry’s state regulators may or may not get that message even if the Federal govern-ment does not. Exiting the Paris accord will not change that picture, induce investors to finance more coal-fired generators or make solar or wind any more expensive than they will be when the subsidies expire (which they will do without any reference to the Paris accord). The biggest industrial losers may be our domestic firms that want to develop "green" products but lose out to better financed, govern-ment sponsored competitors from Europe and Asia.

By Leonard Hyman and Bill Tilles for Oilprice.com

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Leave a comment
  • Dan on June 03 2017 said:
    It looks like we are still heating most mornings through June. Global Warming is a bust.
  • Russ Ramey on June 03 2017 said:
    The Paris agreement is dead as far as I am concerned, another statist ponzi scheme. Compete or go belly up.
  • Naomi on June 03 2017 said:
    I am willing to bet the 3 cent/KWH solar energy cost does not include installation, transmission, and storage costs. It may include government subsidies.
  • Glen Haas on June 06 2017 said:
    Naomi, you are correct. Only battery storage will make solar "more successful." However, the above article does not emphasize the fact that coal, oil, and liquid or natural gas can used the same existing infrastructure. Therefore, it is relatively easy to convert a coal plant to a gas plant. It appears that the U.S. has over 100 years of natural gas reserves due to fracking and converting to gas has provided nearly all of the CO2 reductions over the last 10 years, showing that the U.S. is by far the country with the most CO2 reduction.
    There is no evidence that solar will be able to get within a factor of 3X that of gas or coal and windmills may make it to 2X. Therefore, why will people pay 2X or more if they can get the lowest price from both gas and coal.

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